Firms with Inconsistently Signed Earnings Surprises: Do Potential Investors Use a Counting Heuristic?

Although prior research reports that firms that consistently beat their earnings expectations are rewarded with a market-valuation premium, most firms are inconsistent in the sign of their benchmark performance, sometimes missing and sometimes beating. In this paper, we report the results of multiple experiments to test the idea that potential investors, evaluating firms that have inconsistent benchmark performance, use a counting heuristic to discriminate among them. Our results provide strong support for the hypothesis that these investors distinguish among firms by counting the number of beats and misses they experience over an observed time interval. The judgmental effect of this beat-frequency is incremental to the effect of the magnitude of the beats and misses of the benchmark. Our study has implications for firm managers who have inconsistent benchmark performance, suggesting that market participants do make systematic discriminations among such inconsistent firms. It also has implications for researchers by introducing a new theoretical construct to the literature-namely, the counting heuristic.

The provision of examples as implementation guidance is pervasive in accounting standards. Prior research has established that preparers engage in 'example-based reasoning,' a tendency to favor the accounting treatment in an example, even when the example does not exactly match the transaction at hand. In this paper, we investigate whether fact-weighting guidance counteracts this tendency. Such guidance, now found in some accounting standards, indicates whether particular transaction facts are more important than others in determining the appropriate accounting treatment. Using an experiment, we find that fact-weighting guidance does reduce preparers' tendency to favor the accounting treatment in an example. However, results also suggest that some degree of example-based reasoning persists even with fact-weighting guidance, and that preparers are not fully aware of how fact-weighting guidance affects their judgments. Our findings have practical implications. They suggest to standard setters a potential remedy-namely, fact-weighting guidance-for the misuse of accounting examples. They also provide insights to accounting preparers regarding how fact-weighting guidance influences their judgments in ways they may not anticipate.

Corporate Governance, Accounting Conservatism, and Manipulation

We develop a model to analyze how board governance affects firms' financial reporting choices and managers' incentives to manipulate accounting reports. In our setting, ceteris paribus, conservative accounting is desirable because it allows the board of directors to better oversee the firm's investment decisions. This feature of conservatism, however, causes the manager to manipulate the accounting system to mislead the board and distort its decisions. Effective reporting oversight curtails managers' ability to manipulate, which increases the benefits of conservative accounting and simultaneously reduces its costs. Our model predicts that stronger reporting oversight leads to greater accounting conservatism, manipulation, and investment efficiency. This paper was accepted by Mary Barth, accounting.

Military Experience and Corporate Tax Avoidance

We find that managers with military experience pursue less tax avoidance than other managers and pay an estimated $1-$2 million more in corporate taxes per firm-year. These managers also undertake less aggressive tax planning strategies with smaller tax reserves and fewer tax havens. Although they leave tax money on the table, boards hiring these managers benefit from reductions in other gray areas in corporate reporting. The broad implications are as follows: for employee selection, boards can consider employees' personal characteristics as a control mechanism when outputs are difficult to contract ex ante or measure ex post.

Using IRS Data to Identify Income Shifting Firms

We use confidential Internal Revenue Service (IRS) data on the reported magnitude of U.S.-foreign intercompany transactions to develop a measure of the likelihood that U.S. multinational entities (MNEs) shift income out of the U.S. Results show that the likelihood of net outbound income shifting is positively related to tax haven subsidiaries, high tech operations, income tax incentives, R&D, and foreign profitability, and negatively related to foreign sales, gross profits, size, and capital expenditures. Supplemental analyses explore cross-sectional differences in IRS audit scrutiny of outbound income shifters and aggressive income shifters. Results suggest outbound and aggressive income shifters are no more likely to be audited than other MNEs and that the rate of audit of both outbound shifters and aggressive shifters has decreased since the financial crisis. Our study provides researchers, investors and tax authorities with a measure of the likelihood that a firm engages in net outbound or potentially aggressive income shifting.